Grants or Awards of Stock

If you work for a corporation, you may receive compensation in the form
of stock of that corporation (or perhaps the parent of that corporation). If
the stock is vested when you receive it, you have to report compensation
income at that time. Otherwise the stock is restricted, and you won't report
compensation income until the stock vests.

Terminology:
Various terms we use in this area are interchangeable. Stock is
vested when there's no risk of forfeiture. When we say stock is
restricted, we mean it isn't vested — in other words, there is a
risk of forfeiture.

We'll take you through the rules for grants of vested stock, then explain
the rules for restricted stock.

Vested stock

In general your stock is vested if you can quit your job — or
be fired — without losing some or all of the value of your
stock. For more details on what it means for stock to be vested,
see When Stock Is Vested. Here are the
rules that apply if your stock is vested when you receive it:

Receiving vested stock

If your stock is vested when you receive it, you have to
report compensation income equal to the value of the stock on
the date of the grant or award. That's true even if you don't
sell the stock, so you haven't received any cash.

Example:
Your employer awards you 250 shares of stock worth $40 each. On your
income tax return for that year you must report $10,000 of compensation
income because of this award.

Withholding

If you're an employee, the company has to withhold on the
value of the vested stock you received. The value of the stock,
and the amount withheld, will be included in your Form W-2.

The employer can satisfy the withholding obligation by
withholding an extra amount from your cash compensation — or by
requiring you to deposit the amount of withholding in cash at
the time of the grant. The income tax portion of this
withholding will be a credit on your income tax return for that
year, just like regular income tax withholding from your cash
wages. Be prepared: the withholding may not be enough to cover
the full amount of tax due as a result of the stock grant. The
amount withheld is just an estimate of the tax that will be due
on this income; your actual tax may be higher. Details:
Withholding on Stock.

Non-employees

If you're not an employee, there shouldn't be any withholding
in connection with the stock grant. You may have to make
payments of estimated tax to avoid a penalty at tax time. (See
Guide to Estimated Taxes.) Because the stock is received for
services, this income is subject to the self-employment tax.

Basis of the stock

Your basis in the stock is equal to the amount you paid for
it, if any, plus the amount of income you reported in connection
with the stock grant. Generally the sum of these numbers is the
fair market value of the stock. Your basis doesn't include the
tax withholding, even if you had to pay that amount out of
pocket to receive the stock.

Sale of the stock

When you sell the stock you'll report capital gain or loss,
depending on whether the amount you receive is larger or smaller
than your basis in the stock. The gain or loss will be
short-term is you held the stock one year or less at the time of
the sale. You need to hold it at least a year and a day to have
a long-term capital gain.

Receiving restricted stock

The rules that apply when you receive stock that isn't vested
are quite different. Generally you aren't treated as the owner
for tax purposes until the stock vests. That's both good and
bad. You don't have to pay tax at the time you receive stock
that's not vested. But the amount of tax you pay later when it
vests can be significantly higher. If you think you would be
better off under the rules for vested stock, you can elect to
use those rules, but you have to file the election within 30
days after receiving the stock.

You may have ownership rights for the stock
even though the tax law doesn't treat you as an owner. For
example, unless you've agreed otherwise you're entitled to vote
the stock you receive as an award even if it isn't vested.

No tax when you receive stock

If the stock you receive as compensation isn't vested when
you receive it, you're not required to report income at that
time. Your employer won't withhold or report anything either.
Unless you make the Section 83b Election,
it's as if nothing happened at that time.

Treatment before vesting

As far as the tax law is concerned, you don't own the stock
before it's vested. That means that any dividend paid on the
stock during that period can't be a treated as a dividend.
Instead, the dividend is treated as compensation paid to you by
the company. You should see this income on your Form W-2, not a
Form 1099-DIV.

Income when stock vests

When the stock vests, you're required to report compensation
income equal to the fair market value of the stock. The fair
market value is determined as of the time the stock vests.

Example:
You receive 1,000 shares of stock at a time when the value of one
share is $20.00. The stock vests a year later when it's worth
$35.00 per share. You're required to report $35,000 of
compensation income at that time.

This income is subject to withholding if you're an employee, and should
be reported on your Form W-2. Because no cash is being paid at this time,
withholding (and any tax not covered by withholding) must be paid from other
resources.

Warning! Tax Pain Ahead! It's
important to focus on the consequences of the rule explained
above. During the period you're waiting for your stock to vest,
any increase in the value of the stock is going to result in
ordinary compensation income, not capital gain. In many cases it
makes sense to consider the Section 83b
Election as a way to avoid this result.

Basis and holding period

For the period before the stock vests, your basis is equal to
the amount you paid for it, if any. In other words, if you
didn't pay anything for the stock, your basis is zero. After the
stock vests, your basis includes the amount you reported as
income when the stock vested (in addition to the amount you paid
for the stock, if any).

Example:
You received a grant of restricted stock and didn't make the
section 83b election. When the stock vested it was worth $27,000
and you reported that amount as compensation income. Your basis
is the stock is $27,000, so you would report only $1,000 of gain
if you sold it for $28,000.

For tax purposes your holding period for the stock begins when it becomes
vested. You need to hold the stock at least a year and a day after the
vesting date to qualify for a long-term capital gain when you sell it.

Example:
You received a grant of restricted stock and didn't make the
section 83b election. The stock vested a year later, and nine
months after that you sold the stock. Although you actually held
the stock 21 months, for tax purposes you only get credit for
holding it nine months. Any gain or loss on the sale will be
short-term.

Section 83b election

If you make the section 83b election, your stock will be
treated as vested stock even if it's restricted. This election
isn't always a good idea, but in some cases it's a big
tax-saver. For details see Section 83b
Election.